What Depression? Private Equity Firms Have TOO MUCH Money

1 July 2010.

Only on Wall Street, in the rarefied realm of buyout moguls, could you actually have too much money.

Private collateral firms, where corporate takeovers are planned and plotted, today sit down atop an estimated $500 billion.

But the offer makers are desperate to discover deals worth doing, and the clock is ticking.

Public pension money, university endowments, insurance companies and other institutions

have promised to invest many billions along with them —

provided the deal makers can find companies to buy.

If they fail, traders can walk away, taking profitable business with them.

Private equity funds generally tie up investors’ money with regard to 10 years.

But they typically must commit all the money within the first three to five years of the funds’ life.

For large buyout funds raised within 2006 and 2007, at the height of the bubble, period is short.

They must invest their money soon or return it to clients —

presumably along with some of the management fees the firms have already gathered.

Corporate buyout specialists generally raise money from big investors and then buy undervalued or underappreciated companies.

To maximize investment returns, they typically leverage their cash with loans from banks or bond investors.

In the past few years, private investment firms have amassed business empires rivaling the mightiest public corporations,

buying up big names like Hilton Hotels, Dunkin’ Donuts and Neiman Marcus.

Critics contend that leveraged buyouts can saddle takeover targets with dangerous levels of debt, according to this short article in the New York Times.

But in contrast to indebted homeowners, highly utilized companies under the care of private equity have so far dodged the big bust many have predicted.

After a good unprecedented burst of buyouts throughout the boom leading up to 2008, an enormous majority of these companies are dangling on.

Whether they will avoid a reckoning is uncertain.

So for now acquistion artists are searching for their subsequent act.

Some of the industry’s biggest players –

David M. Rubenstein of the Carlyle Group, Henry Kravis of Kohlberg Kravis Roberts and David Bonderman associated with TPG –

have more than $10 billion apiece in uncommitted capital —

what is known as “dry powder” —

according to Preqin, an industry research firm.

Some buyout firms are asking their clients for more time to search for companies to buy.

Many more are rushing to invest their cash as quickly as possible, whatever the price.

Many in the industry are getting caught in bidding wars.

Firms are assigning surprisingly high values to companies they are acquiring,

even though the lofty prices will in all likelihood reduce profits for their investors.

A big drop in returns would be particularly vexing for pension funds,

which are counting on private equity, hedge funds and other so-called alternative opportunities to help them meet their installation liabilities.

Given the prices being paid for companies, investors’ returns over the life of the actual fund are likely to drop into the low to mid-teens,

said Hugh H. MacArthur, head of global private equity at the consulting firm Bain & Company,

which used to be associated with Bain Capital, the private equity company.

Returns will be even lower as soon as fees are factored in.

Private collateral firms typically charge a yearly fee of 2 percent and take a 20 percent cut associated with a profits.

While investing in private equity will probably be more lucrative than investing in public markets,

“those are not even close to the gross returns of the mid- to high teens that people saw a few years ago,” Mr. MacArthur said.

One factor in the modest forecast is rising prices for buyouts.

Kelly DePonte, a partner at Probitas Partners in Bay area, which helps private equity firms raise cash, said

“tough competition for deals” had driven up valuations recently.

One of the biggest and costliest deals so far this year was the acquisition of a stake in the Interactive Information Corporation,

a financial market data company, by two private equity firms, Silver Lake and Warburg Pincus,

according to Capital IQ, that tracks the industry.

A third, unidentified private equity partner dropped away because the price was excessive.

The two buyout shops compensated $3.4 billion, or $33.Eighty six in cash for each share of I.D.D. —

a premium of nearly Thirty-three percent to the going cost in the stock market.

Technology companies frequently command high valuations.

Silver River and Warburg Pincus declined in order to comment for this article.

Last year, when banks balked at financing deals and private equity companies worried the economic crisis would drag on,

the number of deals — and prices paid — fell sharply.

In This summer 2009, for instance, Apax Partners paid $28.50 a share, or $571 million, for Bankrate,

which owned a number of consumer finance Web sites.

The cost represented a 15.Eight percent premium.

Apax had to pay the entire bill itself, without any money from banks.

But these days, even small and midsize companies are inside a bidding frenzy.

More than a dozen buyout firms made preliminary bids for the Virtual Radiologic Company,

a company that interprets healthcare images remotely.

Providence Equity Partners eventually paid a 41 percent premium for the company.

When a small online education organization called Plato Learning hung up the “for sale” sign, several suitors demonstrated interest.

When Plato last tried to market itself, in the fall of 2007, it found absolutely no takers.

Private equity players concede that competition has heated up and prices are rising.

But they reason that prices, from a historical perspective, remain attractive.

Prices are well underneath the stratospheric levels of 2007 and 2008, according to Capital IQ.

Buyout executives also say it is too quickly to determine what profits will come from all of these deals.

And, they say, losers within bidding wars always claim the winners overpaid.

Still, those with dry powder are bidding aggressively, in the United States, Europe and Asia.

TPG — which, according to Preqin, has one of the largest stockpiles from more than $18 billion —

has bid strongly at several auctions, according to several investment bankers.

In fact, TPG has spent $9.2 billion to date this year, investing in 11 businesses, including ones in India and Brazil.

That makes TPG the industry’s top deal maker, according to Dealogic, a research firm.

A spokesperson for TPG declined to remark.

Noting that buyout firms tend to be “feeling a lot of pressure to put the money to work,”

William R. Atwood, head of the Illinois State Board of Investment, said he wished the firms would not stretch too much for deals.

“There is a large counterpressure — a requirement for prudence as well as returns from their investments,” he said.

As literally millions of Americans and other people around the world struggle daily to outlive,

Wall Street big shots possess, literally, more money than they get sound advice with.

David Caploe PhD

Editor-in-Chief

EconomyWatch.com

President / acalaha.com